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Accounting for the Effects of US Tax Reform Under IFRS

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The U.S. tax reform legislation signed into law in December may present challenges for some organizations that prepare their financial statements using International Financial Reporting Standards (IFRS). “Challenges could arise in determining how an aspect of the legislation applies to an organization’s specific facts and circumstances, in gathering data to quantify that application or a combination of the two,” says Todd Izzo, partner, International Tax, Deloitte Tax LLP.

Todd Izzo

The most immediate impact likely will be on how organizations apply the standard known as IAS 12 Income Taxes in light of the U.S. tax law changes.

The legislation reduced the U.S. corporate tax rate to 21%, and that change may have an accounting treatment impact on deferred tax assets (DTAs) and deferred tax liabilities (DTLs). Under IAS 12, organizations are required to measure DTAs and DTLs at the enacted tax rates that are expected to apply to the period when the asset is realized or the liability settled. Generally, that means organizations must adjust the DTAs and DTLs in their financial statements for reporting periods ending on or after the enactment date, which is December 22, 2017.

“Calendar year-end organizations with DTAs and DTLs that exist as of the enactment date, and are expected to reverse after the legislation’s January 1, 2018, effective date, should be adjusted to the new statutory tax rate of 21%,” notes Paul Vitola, partner, Washington National Tax Group, Deloitte Tax LLP. “However, any DTAs and DTLs expected to reverse before the effective date would not be affected by the new statutory tax rate,” says Mr. Vitola.

Paul Vitola

Deferred tax balances may be related to items that were previously recognized outside of profit and loss, for example, in other comprehensive income (OCI) or directly in equity. The impact of the rate change on such balances should be recognized either in OCI or equity consistent with the recognition of the original amounts. That is, the impact should be backward traced to either OCI or equity.

In addition, organizations should understand how the IRS expects the blended tax rate resulting from the change is calculated. Mr. Vitola explains that the blended rate is based on the applicable rates before and after the December 22, 2017, rate change, and the number of days in the period within the taxable year before and after the effective date of the change. However, he points out that the calculation is not affected by the timing of income generated during the year (See Fig. 1).

ENLARGE

Modification of NOL Carryforwards

The legislation also modifies aspects of the tax law with respect to net operating loss (NOL) carryforwards. Under the old law, NOLs generally had a carryback period of two years and a carryforward period of 20 years. The new law eliminates, with certain exceptions, the NOL carryback period and permits an indefinite carryforward period. The amount of the NOL deduction is limited to 80% of taxable income, which is computed without regard to the NOL deduction.

The change in NOL utilization may affect recognition of related DTAs, particularly when considering future taxable income to justify the recognition of a DTA. “In that case, an organization should look to, among other things, the future reversals of existing taxable temporary differences in periods prior to expiration of the NOL,” comments Mr. Izzo.

The losses arising in taxable years beginning after December 31, 2017 will not expire. As a result, the pool of taxable temporary differences that may be available to justify recognition of DTAs for deductible temporary differences may be expanded and include, for example, the taxable temporary difference associated with an indefinite‑life asset.

Global Intangible Low‑taxed Income

The legislation also creates a new inclusion requirement for gross income called global intangible low-taxed income (GILTI). GILTI refers to certain income earned by controlled foreign corporations (CFCs) that must be included in the gross income of the CFCs’ U.S. shareholder in the period it arises.

Consider the accounting treatment of a DTL as it relates to a taxable outside basis difference. The DTL is not recognized if the organization is able to control the timing of the reversal of the temporary difference and it is probable that this reversal will not arise in the foreseeable future.

A question emerges, however, as to whether the reduction of a taxable outside basis difference that arises as a result of a GILTI inclusion should be considered as a probable reversal for which a DTL needs to be recognized.

IAS 12 does not provide clear guidance on whether, and how, certain aspects of GILTI may affect the recognition of DTLs related to the outside basis differences from foreign investees. For example, under IAS 12, the recognition of a DTL with respect to a taxable outside basis from investees is assessed investee by investee, whereas for tax purposes, GILTI is established by aggregating income from foreign investees.

There may also be significant practical difficulties in applying the principles of IAS 12 to GILTI. In particular, the computation of GILTI is subject to future and contingent events. Such events may render a high level of uncertainty for some organizations with respect to the estimation of whether, and to what extent, an organization will have a GILTI inclusion in a specific future year when existing inside basis differences are scheduled to reverse.

Due to these various complexities, organizations should consider whether the effects of GILTI should be accounted for as part of the recognition and measurement of deferred taxes or as an income tax expense in the period incurred, adds Mr. Vitola.

Base Erosion Anti‑abuse Tax

Organizations that begin their fiscal years after December 31, 2017, are potentially subject to tax under the base erosion anti-abuse tax (BEAT) provision if the controlled group of which it is a part has sufficient gross receipts and derives a sufficient level of “base erosion tax benefits.” Under the BEAT, an organization must pay a base erosion minimum tax amount (BEMTA) in addition to its regular tax liability after credits.

“Because the amounts that may be payable under the BEAT provisions are based on a notion of taxable profit, it is an income tax within the scope of IAS 12,” Mr. Izzo says.

As a result, an organization may want to consider the following elements when assessing the impact of the BEAT:

—The BEAT provision is designed to be an “incremental tax,” and accordingly an entity can never pay less than its statutory tax rate of 21% under the new law.

—The entity may not know whether it will always be subject to the BEAT tax.

—It is expected that most, if not all, taxpayers will ultimately take measures to reduce their BEMTA exposure and therefore ultimately pay taxes at or as close to the regular rate as possible.

Corporate AMT

The corporate alternative minimum tax (AMT) has been repealed for fiscal years beginning after December 31, 2017. Organizations with AMT credit carryforwards that have not yet been used may claim a refund in future years for those credits even though no income tax liability exists.

Because the AMT credit is now fully refundable regardless of whether there is a future income tax liability before AMT credits, the benefit of the AMT credit will be realized. Therefore, organizations using IFRS will need to recognize an asset with respect of AMT credit carryforwards for which recovery was not previously probable, and therefore did not qualify for recognition as a DTA.

The AMT credit may be utilized against future regular tax liability arising in certain future years or be refunded. IAS 12 is not clear as to the classification of unused income tax credits that may be realized in cash or as a reduction of future income tax payable. Entities should consider whether to classify their AMT credit carryforwards as a deferred tax asset or income tax receivable. Entities should be cognizant of the ancillary impacts of such determination, for example, if classified as an income tax receivable an entity should consider discounting and classification of a portion as a current asset.

Disclosures

The quality of disclosures on income tax is already an area of regulatory focus, particularly around the effective tax rate reconciliation required by IAS 12. The reconciliation should provide clear information about the key factors affecting the effective tax rate and its sustainability in the future. “Further, proper identification and explanation of significant effects of the legislation in the reconciliation will assist in a user’s understanding of how the effective tax rate has changed and to distinguish between ‘one‑off’ effects of the law’s introduction and effects that are expected to recur,” suggests Mr. Vitola.

Organizations may want to consider how the process of accounting for the new law should be reflected in the disclosures required by IAS 1, the IFRS standard related to presentation of financial statements. Areas of review can include those in which the most significant judgements are made in applying accounting policies, as well as the major sources of estimation uncertainty—such as assumptions made about the future—that have a significant risk of resulting in a material adjustment to the carrying amount of assets and liabilities in the next financial year.

While challenges may emerge as financial reporting teams work through IFRS accounting issues with respect to the new U.S. tax legislation, organizations should make their best estimate of all effects of the law’s provisions in their financial statements, and provide disclosures regarding significant judgements and estimation uncertainties as necessary. “Further, as new information becomes available or understanding of the law is refined in subsequent periods, those estimates should be revised,” adds Mr. Izzo.

For more insights into potential IFRS accounting impacts of U.S. tax reform read Deloitte’s IFRS in Focus newsletter.

Accounting for the Effects of US Tax Reform Under IFRS

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